Question 1

Consider the following formula: VL = VU + τcD
The term τcD represents:

Accepted Answer

A) the present value of the interest tax shield. 
B) the value of the firm with leverage. 
C) the present value of the future interest payments. 
D) the interest tax shield each year. 
A) the present value of the interest tax shield. 
B) the value of the firm with leverage. 
C) the present value of the future interest payments. 
D) the interest tax shield each year.

Question 2

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff's interest tax shield is closest to:

Accepted Answer

A) $10 million. 
B) $18 million. 
C) $11 million. 
D) $13 million. 
A) $10 million. 
B) $18 million. 
C) $11 million. 
D) $13 million.

Question 3

Use the information for the question(s)below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt.KD has had consistently stable earnings,and pays a 21% tax rate.Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-If KD expects the share price to increase from $20 per share to a new share price on announcement of the transaction and before the shares are repurchased,what will the new share price be after the announcement?

Accepted Answer

A) $21.40 
B) $22.65 
C) $22.00 
D) $23.50 
A) $21.40 
B) $22.65 
C) $22.00 
D) $23.50

Question 4

Galt Industries has 125 million shares outstanding and has a corporate tax rate of 21%.Galt announces that it will use $75 million in excess cash to repurchase shares.Shareholders had previously assumed that Galt would retain this excess cash permanently.The amount Galt's share price can be expected to change upon this announcement is closest to:

Accepted Answer

A) $0.13. 
B) $0.24. 
C) $0.36. 
D) $0.39. 
A) $0.13. 
B) $0.24. 
C) $0.36. 
D) $0.39.

Question 5

Use the following information to answer the question(s)below.
Google Corporation has no debt on its balance sheet in 2008,but paid $1.6 billion in taxes.Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors hold Google stock in retirement accounts that are free from personal taxes.If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently,then the value that would be created is closest to:

Accepted Answer

A) $6.4 billion. 
B) $8.6 billion. 
C) $9.8 billion. 
D) $14.3 billion. 
A) $6.4 billion. 
B) $8.6 billion. 
C) $9.8 billion. 
D) $14.3 billion.

Question 6

Use the following information to answer the question(s)below.
Wyatt Oil issued $100 million in perpetual debt (at par)with an annual coupon of 7%.Wyatt will pay interest only on this debt.Wyatt's corporate tax rate is expected to be 21% for the foreseeable future.
-Wyatt's annual interest tax shield is closest to:

Accepted Answer

A) $1.47 million. 
B) $4.20 million. 
C) $7.00 million. 
D) $40 million. 
A) $1.47 million. 
B) $4.20 million. 
C) $7.00 million. 
D) $40 million.

Question 7

Use the information for the question(s)below.
Rosewood Industries has EBIT of $450 million,interest expense of $175 million,and a corporate tax rate of 21%.
-The amount of Rosewood's interest tax shield is closest to:

Accepted Answer

A) $115 million. 
B) $290 million. 
C) $175 million. 
D) $37 million. 
A) $115 million. 
B) $290 million. 
C) $175 million. 
D) $37 million.

Question 8

Use the information for the question(s)below.
KD Industries has 30 million shares outstanding with a market price of $20 per share and no debt.KD has had consistently stable earnings,and pays a 21% tax rate.Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares.
-The value of KD's unlevered equity is closest to:

Accepted Answer

A) $600 million. 
B) $470 million. 
C) $390 million. 
D) $400 million. 
A) $600 million. 
B) $470 million. 
C) $390 million. 
D) $400 million.

Question 9

Use the information for the question(s)below.
Shepard Industries expects free cash flow of $10 million each year.Shepard's corporate tax rate is 21%,and its unlevered cost of equity is 10%.The firm also has outstanding debt of $40 million and it expects to maintain amount of debt permanently.
-The value of Shepard Industries without leverage is closest to:

Accepted Answer

A) $114 million. 
B) $50 million. 
C) $100 million. 
D) $64 million. 
A) $114 million. 
B) $50 million. 
C) $100 million. 
D) $64 million.

Question 10

Taggart Transcontinental currently has no debt and an equity cost of capital of 16%.Suppose that Taggart decides to increase its leverage and maintain a market debt-to-value ratio of 1/3.Suppose Taggart's debt cost of capital is 9% and its corporate tax rate is 21%.Assuming that Taggart's pre-tax WACC remains constant,then with the addition of leverage its effective after-tax WACC will be closest to:

Accepted Answer

A) 12.9%. 
B) 13.0%. 
C) 15.4%. 
D) 16.0%. 
A) 12.9%. 
B) 13.0%. 
C) 15.4%. 
D) 16.0%.

Question 11

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:

Accepted Answer

A) $114 million. 
B) $100 million. 
C) $107 million. 
D) $140 million. 
A) $114 million. 
B) $100 million. 
C) $107 million. 
D) $140 million.

Question 12

Use the information for the question(s)below.
LCMS Industries has $70 million in debt outstanding.The firm will pay only interest on this debt (the debt is perpetual).LCMS' corporate tax rate is 21% and the firm pays a rate of 8% interest on its debt.
-The present value of LCMS' interest tax shield is closest to:

Accepted Answer

A) $45.5 million. 
B) $20.0 million. 
C) $14.7 million. 
D) $35.0 million. 
A) $45.5 million. 
B) $20.0 million. 
C) $14.7 million. 
D) $35.0 million.

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) If there is uncertainty regarding EBIT,then with a higher interest expense there is a greater risk that interest will exceed EBIT. 
B) Even for a firm with positive earnings,growth will affect the optimal leverage ratio. 
C) From a tax perspective,the firm's optimal level of debt is proportional to its current earnings. 
D) The optimal proportion of debt in the firm's capital structure will be higher,the higher the firm's growth rate. 
A) If there is uncertainty regarding EBIT,then with a higher interest expense there is a greater risk that interest will exceed EBIT. 
B) Even for a firm with positive earnings,growth will affect the optimal leverage ratio. 
C) From a tax perspective,the firm's optimal level of debt is proportional to its current earnings. 
D) The optimal proportion of debt in the firm's capital structure will be higher,the higher the firm's growth rate.

Question 14

Assume that investors hold Google stock in retirement accounts that are free from personal taxes.Also assume that Google's current pre-tax WACC is 14% and the corporate tax rate is 21%.If Google were to issue sufficient debt at a pre-tax cost of 7% to give them a debt-to-value ratio of 0.5,then the Google's after-tax WACC would be closest to:

Accepted Answer

A) 10.4%. 
B) 12.8%. 
C) 13.0%. 
D) 15.0%. 
E) 16.0%. 
A) 10.4%. 
B) 12.8%. 
C) 13.0%. 
D) 15.0%. 
E) 16.0%.

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) Even though firms have not issued new equity,the market value of equity has risen over time as firms have grown. 
B) While firms seem to prefer debt when raising external funds,not all investment is externally funded. 
C) To receive the full tax benefits of leverage a firm needs to use 100% debt financing. 
D) If bankruptcy is costly,these costs might offset the tax advantages of debt financing. 
A) Even though firms have not issued new equity,the market value of equity has risen over time as firms have grown. 
B) While firms seem to prefer debt when raising external funds,not all investment is externally funded. 
C) To receive the full tax benefits of leverage a firm needs to use 100% debt financing. 
D) If bankruptcy is costly,these costs might offset the tax advantages of debt financing.

Question 16

Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a debt to equity ratio of 1,then the value of Flagstaff as a levered firm is closest to:

Accepted Answer

A) $114 million. 
B) $100 million. 
C) $111 million. 
D) $128 million. 
A) $114 million. 
B) $100 million. 
C) $111 million. 
D) $128 million.

Question 17

Use the following information to answer the question(s)below.
Google Corporation has no debt on its balance sheet in 2008,but paid $1.6 billion in taxes.Assume that Google's marginal tax rate is 35% and Google's borrowing cost is 7%.
-Assume that investors in Google pay a 15% tax rate on income from equity and a 25% tax rate on interest income.If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently,then the effective tax advantage of this debt would be closest to:

Accepted Answer

A) 10%. 
B) 15%. 
C) 25%. 
D) 30%. 
A) 10%. 
B) 15%. 
C) 25%. 
D) 30%.

Consider the following formula: VL = VU + τcD The term τcD represents:

Use the information for the question(s)below. Rosewood Industries has EBIT of $450 million,interest expense of $175 million,and a corporate tax rate of 21%. -The amount of Rosewood's interest tax shield is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Exam 15: Debt and Taxes

Consider the following formula: VL = VU + τcD The term τcD represents:

Use the information for the question(s)below. Rosewood Industries has EBIT of $450 million,interest expense of $175 million,and a corporate tax rate of 21%. -The amount of Rosewood's interest tax shield is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters